What Can Possibly Explain the Price of Oil? 16 comments
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What can possibly explain the behavior of the price of oil? The Senate committee has heard testimony from a variety of sources and a variety of viewpoints ranging from accusing the regulators to be tacit participants in market manipulation to “Peak Oil”.
This same sort of back and forth happens whenever we have bubbles forming. There are always those who argue that it is simply a speculative mania, and then there are the true “believers” who bring arguments and evidence why things have changed.
To show you how difficult it is to make any sense of this, consider that two very smart and very wealthy investors find themselves on opposite sides of the argument: George Soros believes there is a bubble, while his ex-partner, Jim Rogers, feels the opposite is true.
But it isn’t difficult to see why many believe that the price of oil no longer represents a true picture of the value of this commodity; after all, it has more than doubled within the span of less than two years:
Note that the chart above is using a logarithmic axis for price and even then you can see that the slope of the rise from 2007 to present is much steeper than that between 2002 - 2006. Here’s an even more long term chart of crude, this time adjusted for inflation:
Source: St. Louis Fed (FRED database)
Oil Shock
This chart clearly shows that the world economy is undergoing a severe “oil shock”. One that pales in comparison to ones which we’ve seen so far in either the Gulf War or the 1979 Iranian Revolution (or the 1973-4 oil embargo - not shown on chart). Which goes a long way in explaining why consumer sentiment is at multi-decade lows.
One of the defining characteristics of a mania is a parabolic chart: increasingly steep price curve within a shorter and shorter time frame. And clearly, that is what we are seeing. While there may be disagreements whether this is really a bubble, what most can not deny is that the rise we have seen so far is just unsustainable if projected into the future.
Perfect Storm
My gut feeling is that we are seeing a confluence of forces, among them, long only commodity funds, a weak dollar, negative real interest rates (which always increase commodity prices) and demand from an increasingly voracious industrial complex in China and India.
But the fact that the increase in price has come in such a short time and it has been so incredibly sharp tells me that it can not be simply explained by the usual market forces of demand and supply. Something else must be at work to drive the price of crude as high as it has done within such a short time span. But only time will reveal what exactly what that “something else” is.
If you doubt that bubbles can not form in “real assets” then you’ve probably overlooked a lot of examples from history: the Japanese real estate bubble, gold, silver, etc. And if you believe that market manipulation is impossible or the overworked imagination of conspiracy theorists, then I would remind you of the California electricity crisis in 2000.
Silver Lining
If the price of oil here truly represents real demand and supply the potential silver lining on such a cloud is that it will not only change people’s consumption habits, it will spur on the development of better alternative energy sources. This is what I don’t understand, if you are a dyed in the wool “peak oil” believer, why invest in a dying industry? why not invest in those companies which will rise up out of the ashes and propel us forward? or do the “peak oilers” believe we are going to regress technologically?
Or consider it another way, if you were to go back in time, would you try to corner the whale oil market? or invest in Texas oil fields?
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Reneables will not substitute currently 1 cubic mile of yearly oil consumption. While reneables are being developed and implemented, the price of oil will still rise skyhigh.
So it still makes perfect sense to invest in oil even if you are a peak oil believer.
- Morgan Stanley predicts oil will hit $150 by July 4th
- Jobs report was horrible, unemployment rises to 5.5%
- Israeli cabinet minister says attack on Iran inevitable
I personally think the Morgan Stanley should be investigated by the SEC. They're simply spreading the fear. There was nothing in their report that we didn't know already. And their timing is very suspicious.
One more time... 85% of U.S. oil and gas reserves are off limits to new exploration courtesy of the Greens and their fellow travelers in the Congress. This self-imposed boycott is responsible for the skyrocketing price of energy, not speculators. It's NOT speculating when you're betting on a SURE THING...!!!
Oh, and sure, let's investigate Morgan Stanley. Simply predicting the future price of oil must be against the law somehow. Indeed, I'm certain it will be once the Greens move into the White House next January.
As their new leader likes to say, "Change you can believe in!"
When did we EVER hear that sort of talk from OPEC?
Is it a bubble when a group responsible for 40% of world production of a commodity that is absolutely essential to the world (and for which we do not have ready substitutes) completely changes its plans regarding its production of that commodity?
I don't know where oil will be in 6 months or in a year because I don't know what OPEC's new "set-point" for oil is. But if you tell me what OPEC will do, I will tell you what oil prices will be.
In summary, if OPEC is telling us (as one of its chiefs did on 6-5-08) that it might actually REDUCE production, then $150 oil is not a BUBBLE--but rather, it is a BARGAIN.
Jack
Men swap commodities. Some call this swap an exchange. In truth, men swap rights, one right for another right. With oil and money, men swap the right of owning oil for the right of owning money.
All swaps must have one commodity exchanged for another. When one thing gets calculated in terms of another, we call this a ratio. The result of the ratio, we call it a value. When we use money as one commodity in the swap, we give another name to the word value -- PRICE.
The ratio of one commodity (oil) to another (money) expresses a value, which we call a price (of oil).
A rise in price means a change in the ratio has happened calculated at one time from being calculated at another time.
Only two ways can achieve a price rise:
[1] money rising quicker than oil
[2] oil falling quicker than money
Each year, a RECORD AMOUNT of oil gets pumped. Since the price (the value) of the ratio is rising, only one cause can be true -- a RISE IN MONEY quicker than a rise in oil.
Sellers sell to the highest bidder. When folks have more money bidding for a near fixed amount of oil (slightly growing in amount year-to-year), prices rise.
There isn't a global oil shortage. There's a GLOBAL GLUT of MONEY.
What caused the Global Glut of Money?
Money is the highest form of Credit and Credit is another word for Debt. Credit and Debt are other names for Capital.
As credit (=debt, =capital) grows for bad products that nobody wants, a collapse of trust follows. Deals get broken and folks walk away paying on debt. Yet, the money created for this debt stays in the pockets of some folks.
It is the default on credit (=debt, =capital) that causes problems. This increases money at a rate quicker than credit for good products, good invention.
When credit (debt) defaults rise, the paper money and coins issued go into the pockets of winners. These winners begin to bid up prices on existing things, typically commodities of energy, metals, food.
Why? Simply, these winners cannot find worthy investments to make, which would turn their notes and coins into capital paying a return.
Money flows into oil futures games because those with money cannot find other games worthy to play.
There is almost certainly some speculative fat in the current price of petroleum. But try to remember that Texas, the North Sea, Indonesia, Prudhoe Bay and Mexico's Cantarell field have are all in decline after having been managed with the most modern technologies and aggressive operational regimes. Oil fields are finite sources of the stuff and virtually all of the big fields have been found and developed.
So perhaps, just perhaps, the recent run up in oil prices is a result of the beginning of awareness of the finite nature and unique characteristics of petroleum.
But it sure ain't the fault of the hapless "Greens" who couldn't manipulate a congressman or presidential candidate if they had him (or her) locked up in the back of a Prius.
What will happen before Bush leaves office is an Israeli strike or more on Iran's uranium enrichment facilities. What remains to be seen is whether Iran is able to sink one or more supertankers in the Straits of Hormuz. Block that and $200 will be a bargain.
There will still be plenty of oil. But the inability to access it will be crippled. 25% of the world's oil would be blocked. Oil Blockade anyone? See the US in the 70's and you get the idea.
"Unavoidable" was the word used by the next Israeli PM. Israel cannot afford to wait. The next US president may seek to appease Iran just like Clinton's success with North Korea in the 90's. Ergo the Israeli's will strike before then.
Talk about Enron...none of you (even you Jack Yetiv ) understand why Enron was able to do what Enron did.
NYMEX CEO used to work for the CFTC...CFTC economist Jeffrey Harris gives a report to the US Senate that is B/S and people believe the guy.
Rep. Bart Stupak says Goldman and MorganStanley are manipulating oil markets and 95 % of you don't even THINK is it POSSIBLE?
I have read four reports on why, how and when the manipulating of commodity prices began.
Go to Phil Davis and Anthony Schneider on SeekingAlpha and download the reports with the links. Go to The LA Times and Bloomberg and search Oil Futures and check out who owns the Intercontinental Exchange and how ICE is involved in speculation and price fixing along with other, worldwide, commodity exchanges.
When you have done all this work ( as I have) you will not think that commodities futures are a "sure thing". Believe me or play the bubble game.
Thanks Babak for an interesting and worthwhile article.
I am not long or short in any commodities. I do not invest money in puts and calls either. And so I have no interest in the outcome of my post other than as a consumer, who, like other consumers, is wondering if people will come to their senses and stop the speculation that is going on.
1) Fanatics in Iran sink one or two tankers in the Persian Gulf cutting off oil exports from Gulf oil producers -- Kuwait, Iran, UAE and Qatar. But not completely. Shallow draft small tankers can still go through. Crude oil goes up to $200 or more, temporarily. The Saudis will ship 5 million bbls/day of their oil via pipeline to the red sea. Iraq ship via Turkey. Iran and Kuwait have no such alternative for exporting their oil. Consumers are already cutting back on their use so a price spike will not hurt the world economy too badly. Non-oil producing countries but oil dependent, with large populations like Pakistan, Egypt will hurt most.
2) Level headed Iranian Mullahs prevail and tankers continue plying the gulf. The leadership figures that if they blockaded the gulf, Iran will be the first to suffer. Their oil revenue will plummet, people lose their means of earning a living and revolt, and the mullahs lose power. Surely, with strong self interest in mind, the level headed Mullahs will not allow blockage of the Straight of Hormuz.
However, whether it is scenario 1 or 2, bombing of Iran will send shock waves to the market and oil will spike to $200+ for a few days and come back down. Nothing to worry about long term. Suicide bombers will try to do damage to the world but the world security forces are already operating around to world now so damage will be limited unlike pre-911.
In the long run the world will benefit from this sir strike. If there is a good time for this event, it will be after the Olympics.
Good money making venture huh? Hey Mark Twain, I hear there's an opening at the Natanz nuclear power plant , night shift. Good pay too! Maybe you should check it out.
A war with Iran would be disastrous for the US. BushCo already is strong arming Iraq for 80% of that nations reserves. Why do we need Iran? Their production has been in decline for years and is really only a relatively small producer today. Is it possible that Iran is actually running out of oil (peak oil) and may actually need nuclear power?
MAD would apply to them as it did to the USSR during the cold war. The one's in charge of Iran are not suicidal maniacs like AlQaida who will die for their cause. The Iranian "threat" being posed by BushCo is really just another resources grab by the US.
What are u referring to..? Bush grabbed oil from Iraq? Where is it? If he did the Democrats would of told us!!
I heard he is trying to get the U.S. the money back we are spending on the war and infrastructure. Is that what you omitted to include